Balaji Venkataraman, VP and Client Portfolio Manager at American Century Investments, has published two papers on how macroeconomic developments may create opportunities for bond investors.
The current market environment is characterized by high interest rates and low jobless rates, a seeming contradiction. Historically, jobless rates have been stable to declining during Federal Reserve (Fed) tightening cycles. Fed policy impacts the economy with a lag, with today’s higher interest rates likely to slow the future economy and lead to rising unemployment. In four of the last five tightening cycles since the 1980s, unemployment rose at least two percentage points one to three years after tightening ended. With these historical precedents, Venkataraman notes that unemployment is likely to rise by mid-2025. This slowing may already have started, as the pace of hiring has been declining over the last two years.
As the economy eventually slows, interest rates may move lower. Fading worries about excessive inflation and a strong job market may prompt the Fed to launch a rate cut cycle. After the previous four Fed tightening cycles ended, 10-year Treasury rates fell by an average of 1.2 percentage points in the subsequent two years. If this pattern holds true in the current cycle, extending duration may be a prudent strategy.
Fixed-income investors—especially those in a core-plus strategy—have experienced heightened interest rate volatility over the last two years. These strategies often track a broad market index, meaning they have consistent exposures to high credit risk and longer duration. American Century favors a more dynamic strategy able to quickly respond to prevailing opportunities.
Rather than investing solely in Treasuries and corporate credits, American Century advocates a multisector approach to fixed-income investing. We believe securitized assets, such as asset-backed securities (ABS), may be attractive at this point in the cycle. A flexible, multisector approach has the ability to vary duration and rotate across sector weights based on current and expected bond market conditions.
Fixed income funds should maintain liquidity, so American Century chooses not to leverage its funds or invest in private credit. These strategies tend to amplify risk and illiquidity, which could present challenges if interest rate volatility continues.
Resources:
Interest Rate Concerns? Consider a Multisector Income Strategy
High Interest Rates, Low Jobless Rate: Ordinary or Anomaly?
Duration, which is an indication of the relative sensitivity of a security’s market value to changes in interest rates, is based upon the aggregate of the present value of all principal and interest payments to be received, discounted at the current market rate of interest and expressed in years. The longer the weighted average duration of the fund’s portfolio, the more sensitive its market value is to interest rate fluctuations. Duration is different from maturity in that it attempts to measure the interest rate sensitivity of a security, as opposed to its expected final maturity.
Debt securities issued by the U.S. Treasury and backed by the direct “full faith and credit” pledge of the U.S. government. Treasury securities include bills (maturing in one year or less), notes (maturing in two to 10 years) and bonds (maturing in more than 10 years). They are generally considered among the highest quality and most liquid securities in the world.
Debt instruments issued by corporations, as distinct from those issued by governments, government agencies, or municipalities. Corporate securities typically have the following features: 1) they are taxable, 2) they tend to have more credit (default) risk than government or municipal securities, so they tend to have higher yields than comparable-maturity securities in those sectors; and 3) they are traded on major exchanges, with prices published in newspapers.
A form of securitized debt (defined below), ABS are structured like mortgage-backed securities (MBS, defined below). But instead of mortgage loans or interest in mortgage loans, the underlying assets may include such items as auto loans, home equity loans, student loans, small business loans, and credit card debt. The value of an ABS is affected by changes in the market’s perception of the assets backing the security, the creditworthiness of the servicing agent for the loan pool, the originator of the loans, or the financial institution providing any credit enhancement.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments’ portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
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